Bunting Technology Corporation is a large public company that manufactures the IXQ, a telecommunications component that speeds up Internet transmission over fiber-optic cable. Subsequent to its current year-end, but, before the audited financial statements are issued, a competitor of Bunting launches a new product that increases transmission speed one hundred times more than Bunting’s IXQ and sells for one-tenth of the price. Bunting has approximately eleven months of inventory of the IXQ in inventory, based on the current year’s sales levels.
Bunting’s auditors, Ditesmoi & Quail (DQ), have determined that this subsequent event warrants a write-down of Bunting’s year-end inventory to reflect technological obsolescence. Given that the IXQ is Bunting’s main product, the write-down will be highly material.
DQ argues that this development will result in a permanent change in Bunting’s future earnings potential and cash flows, and it would be misleading users if it is not included in the current year financial statements.
Bunting’s management refuses to record the inventory write-down, arguing that the event occurred after the year-end and therefore does not relate to the current year’s results. Also, since the competitor’s product is brand new, management argues that there is significant uncertainty about whether it will perform as well in actual use as the competitor claims.
Thus, it is premature to assume it will have an impact on IXQ sales, and it is impossible to estimate a dollar amount of the impact. Management is also concerned that, by publicly reporting information about the competing product in Bunting’s annual report, DQ will jeopardize several large sales contracts that Bunting is currently negotiating, and this may lower sales even more than if the information were withheld.
DQ issues a qualified audit report that spells out its estimate of the material impact of the technological obsolescence on Bunting’s assets, net income, and retained earnings.
Discuss the issues raised by DQ’s decision to issue a qualified report in this situation. Consider the impact of DQ’s audit report qualification on Bunting, on users of the audited financial statements, and on DQ as Bunting’s auditor.